nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2023‒03‒27
eight papers chosen by
Martin Berka
Massey University

  1. The Global Dollar Cycle By Maurice Obstfeld; Haonan Zhou
  2. Central Banks as Dollar Lenders of Last Resort: Implications for Regulation and Reserve Holdings By Ms. Mitali Das; Ms. Gita Gopinath; Mr. Taehoon Kim; Jeremy C. Stein
  3. Catching Up by ‘Deglobalizing’: Capital Account Policy and Economic Growth By Paul Bergin; Woo Jin Choi; Ju H. Pyun
  4. On the Effectiveness of Foreign Exchange Reserves During the 2021-22 U.S. Monetary Tightening Cycle By Rashad Ahmed; Joshua Aizenman; Jamel Saadaoui; Gazi Salah Uddin
  5. Is there international risk-sharing between developed economies? New evidence from indirect inference By Minford, Patrick; Ou, Zhirong; Zhu, Zheyi
  6. Bounded Rational Expectation: How It Can Affect the Effectiveness of Monetary Rules in the Open Economy By Dong, Xue; Minford, Patrick; Meenagh, David; Yang, Xiaoliang
  7. On the determination of the real exchange rate in free markets: do consumer risk-pooling and uncovered interest parity differ and fit? By Minford, Patrick; Ou, Zhirong; Zhu, Zheyi
  8. Exchange rate risk and sovereign debt risk in South Africa: A Regime Dependent Approach By Mathias Manguzvane; Mduduzi Biyase

  1. By: Maurice Obstfeld; Haonan Zhou
    Abstract: The U.S. dollar’s nominal effective exchange rate closely tracks global financial conditions, which themselves show a cyclical pattern. Over that cycle, world asset prices, leverage, and capital flows move in concert with global growth, especially influencing the fortunes of emerging and developing economies (EMDEs). This paper documents that dollar appreciation shocks predict economic downturns in EMDEs and highlights policies countries could implement to dampen the effects of dollar fluctuations. Dollar appreciation shocks themselves are highly correlated not just with tighter U.S. monetary policies, but also with measures of U.S. domestic and international dollar funding stress that themselves reflect global investors’ risk appetite. After the initial market panic and upward dollar spike at the start of the COVID-19 pandemic, the dollar fell as global financial conditions eased; but the higher inflation that followed has induced central banks everywhere to tighten monetary policies more recently. The dollar has strengthened considerably since mid-2021 and a contractionary phase of the global financial cycle is now under way. Owing to increases in public- and business-sector debts during the pandemic, a strong dollar, higher interest rates, and slower economic growth will be challenging for EMDEs.
    JEL: E58 F31 F41 F44 O11
    Date: 2023–03
  2. By: Ms. Mitali Das; Ms. Gita Gopinath; Mr. Taehoon Kim; Jeremy C. Stein
    Abstract: This paper explores how non-U.S. central banks behave when firms in their economies engage in currency mismatch, borrowing more heavily in dollars than justified by their operating exposures. We begin by documenting that, in a panel of 53 countries, central bank holdings of dollar reserves are significantly correlated with the dollar-denominated bank borrowing of their non-financial corporate sectors, controlling for a number of known covariates of reserve accumulation. We then build a model in which the central bank can deal with private-sector mismatch, and the associated risk of a domestic financial crisis, in two ways: (i) by imposing ex ante financial regulations such as bank capital requirements; or (ii) by building a stockpile of dollar reserves that allow it to serve as an ex post dollar lender of last resort. The model highlights a novel externality: individual central banks may tend to over-accumulate dollar reserves, relative to what a global planner would choose. This is because individual central banks do not internalize that their hoarding of reserves exacerbates a global scarcity of dollar-denominated safe assets, which lowers dollar interest rates and encourages firms to increase the currency mismatch of their liabilities. Relative to the decentralized outcome, a global planner may prefer stricter financial regulation (e.g., higher bank capital requirements) and reduced holdings of dollar reserves.
    Keywords: Foreign reserves; central banks; currency mismatch; lender of last resort; financial regulation; dollar reserve; bank borrowing; post dollar lender of last resort; dollar interest rates; reserve holding; International reserves; Banking crises; Currency mismatches; Reserves accumulation; Exchange rates; Global
    Date: 2023–01–18
  3. By: Paul Bergin; Woo Jin Choi; Ju H. Pyun
    Abstract: While substantial empirical research has evaluated the question of whether capital account openness promotes economic growth, this paper finds empirical evidence for cases where the opposite is true—that a policy of capital controls can promote economic growth, when combined with a policy of reserve accumulation. Using panel data from 45 countries from 1985–2019, we find that capital controls combined with reserve accumulation—strategic capital account policy—contribute to growth in real GDP and TFP. This effect is stronger for emerging markets and prior to the global financial crisis. We show that the policy is strongly associated with enlarging the scale of the manufacturing sector and productivity, and is consistent with theories of learning-by-doing through exporting.
    JEL: E58 F21 F31 F41
    Date: 2023–02
  4. By: Rashad Ahmed; Joshua Aizenman; Jamel Saadaoui; Gazi Salah Uddin
    Abstract: This paper examines the role of foreign exchange (FX) reserves and other fundamental factors in explaining cross-country differences in foreign currency depreciation observed over the 2021-22 Federal Reserve monetary policy tightening cycle that led to a sharp appreciation of the US dollar. Using a broad cross-section of over 50 countries, we document that an additional 10 percentage points of FX reserves/GDP held ex-ante was associated with 1.5 to 2 percent less exchange rate depreciation. We also find that higher ex-ante policy rates were associated with less depreciation, especially among financially open economies. Taken together, these results support the buffering role of FX reserves and their potential to promote monetary policy independence in the presence of global spillovers.
    JEL: F32 F40 F68
    Date: 2023–02
  5. By: Minford, Patrick (Cardiff Business School); Ou, Zhirong (Cardiff Business School); Zhu, Zheyi (Cardiff Business School)
    Abstract: It has been an `empirical consensus' that data from developed economies generally do not support the hypothesis of international risk-sharing, either in the form of full risk-pooling via state-contingent assets or in the form of uncovered interest parity enforced by trading non-contingent assets. We reassess these hypotheses in the context of a full DSGE model, as opposed to testing them as single regressions in previous work. We prove that the two model versions behave identically, suggesting that consumers would receive the same scope of protection against risks whether bonds are state-contingent. We further find that the model, when tested appropriately as a whole embracing risk-pooling/UIP, fits the data well and universally through the lens of indirect inference; hence, we provide new evidence of the hypotheses' empirical validity spuriously rejected by single regressions.
    Keywords: consumer risk-pooling; UIP; two-country DSGE model; indirect inference test
    JEL: C12 E12 F41
    Date: 2023–02
  6. By: Dong, Xue (Zhejiang University of Finance and Economics, China); Minford, Patrick (Cardiff Business School); Meenagh, David (Cardiff Business School); Yang, Xiaoliang (Cardiff Business School)
    Abstract: Since the channel for agents’ expectations matters for the effectiveness of monetary policies, it is crucial for policy-makers to assess the degree to which economic agents are boundedly rational and understand how the bounded rationality affects the monetary rules in stabilising the economy. We investigate the empirical evidence for the bounded rationality in a small open economy model of the UK, and compare the results with those for the conventional rational expectations model. Overall, comparing the estimated models favours the bounded rationality framework. The results show that bounded rationality model helps to explain the hump-shaped dynamics of real exchange rate following monetary shocks, while the rational expectations model cannot. Also, we find that the exchange rate channel in the bounded rationality enlarges the effects of foreign mark-up shock, policymakers should send stronger signals over its target to the economics agents to combat the inflation. So the bounded rationality that can be found in the data still leaves scope for the forward guidance channel to work strongly enough to be exploited by policymakers.
    Keywords: bounded rationality, monetary policy, small open economy, exchange rate channel
    JEL: E52 E70 F41 C51 F31
    Date: 2023–02
  7. By: Minford, Patrick (Cardiff Business School); Ou, Zhirong (Cardiff Business School); Zhu, Zheyi (Cardiff Business School)
    Abstract: We revisit the ‘puzzle’ in open economy studies that evidence of international risk-sharing is hardly seen despite the completeness of the financial market. We reassess both risk-pooling via state-contingent bonds, and uncovered interest parity – both were believed to be different, and spuriously rejected, in previous work – in the context of a full DSGE model. We prove that the two models are identical, both analytically and numerically. When tested as part of the full DSGE model by indirect inference which circumvents the bias of single-equation tests, we find strong and wide evidence of international risk-sharing.
    Keywords: consumer risk-pooling; UIP; two-country DSGE model; indirect inference test
    JEL: C12 E12 F41
    Date: 2023–02
  8. By: Mathias Manguzvane (College of Business and Economics, School of Economics, University of Johannesburg); Mduduzi Biyase (College of Business and Economics, School of Economics, University of Johannesburg)
    Abstract: We provide novel evidence of the regime specific effect of exchange rate risk on sovereign debt risk in South Africa. Using monthly data from 2008 to 2021 through a Markov regime switching model with time varying probabilities for the transitions, our results show that exchange rate risk matters in determining movements in sovereign debt risk as measured by sovereign credit default swaps (CDS). The results suggest that exchange rate risk exacts a positive and significant impact on sovereign debt risk in both the high risk regime and low risk regime. However, we notice that the magnitude of the impact differs from one regime to the other, implying that sovereign debt risk responds differently to exchange rate risk bull and bear markets
    Keywords: Sovereign debt, Exchange rate, Markov Regime Switching Model, credit default swaps
    Date: 2023

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